Two Words That Explain the Price Movements of Bitcoin

The price of bitcoin increased yesterday following the news that PayPal would integrate the digital currency into its services for merchants. However, the price is still down approximately 50% compared with the start of the year.

Everyone in the bitcoin space is now looking for answers as to why the price has dropped so much from its $1,100 peak in December 2013. In the absence of any new specific information, the simplest answer is the best, and can be summed up in two words: asset allocation.

Simply put, there have been better places to invest since the price started dipping from a relative high in June and July.

Below is a chart of the bitcoin price since it reached that high, versus competing asset classes:

As you can see, the S&P 500 (orange), the Dow 30 (yellow), and the US dollar (red) have all outperformed bitcoin since June, but it's really been the case all year, as the S&P is up 8.8% year to date, and the Dow is up 4.67% year to date.

In other words, money flows to where it can increase, and selling begets more selling in what forms a classic negative feedback loop. As bitcoin keeps going lower, more selling will occur, especially among retailers and miners.

The prevailing attitude is 'why should I hold it today if it will be worth less tomorrow?'. This will continue to be the attitude until proper hedging occurs using various derivative products or the price of bitcoin goes into a sustained uptrend.

USD vs bitcoin

Below is a five-year chart of the US dollar and, as you can see, it is reaching new highs:

The US dollar has significantly outperformed bitcoin since June and July. In fact, the US dollar and bitcoin should be negatively correlated as they are competing assets and 'alternative' forms of currency.

There are many reasons for the US dollar's strength, including:

The end of QE (quantitative easing) by the Federal Reserve in October and the perception of rising interest rates in the US.

The perception of a strong domestic economy.

Money inflows from European countries as their economies have once more started showing signs of contracting.

Money inflows from pound sterling. This could have been related to worries over Scottish secession from the UK, which did not in the end go ahead.

If the US dollar weakens that should be positive for bitcoin.

Future outlook

If a stock market correction happens, money outflowing from equities will look for other asset classes to allocate to. Hence, money could flow towards under-performing assets, such as bitcoin, emerging markets and hard and soft commodities.

Some in the bitcoin community have speculated that the Alibaba IPO has been one of the reasons for the price decline. This could be seen as a positive, though, as all those who were allocated shares at $68 will probably be selling their shares after making a 32% profit very quickly and put that money to use elsewhere.

There is an old rule on Wall Street, as is highlighted in Joe Granville’s book New Strategy of Daily Stock Market Timing for Maximum Profit: “Stocks do not rise in price unless demand exceeds supply. Demand is measured in volume and thus volume must precede price.”

Volume also generally precedes news, as does price. If you are looking for the downtrend to end, keep an eye on volume. If you see it rising (along with price) on good news than accumulation has begun.

To end on a timely note, if we look at bitcoin seasonality, the period beginning in October has seen the price rise in previous years. Perhaps that is a pattern we will see repeated this year.

Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, CoinDesk.